Don’t write off Salvini Demise of the Italian strongman suits the EU, but he is not finished yet Ambrose Evanspritchard
Be careful what you wish for in Italian politics. The exile of the volcanic Matteo Salvini is a Faustian bargain for the EU establishment and the defenders of the euro project. There must be a high chance that the Lega strongman – and de facto leader of the Continent’s anti-eu rebellion – will sweep back into power with an overwhelming majority next year or soon after.
He may then be strong enough to push revolutionary changes through the Italian constitutional system, including a New Deal spending blitz backed by a politically controlled Bank of Italy and a parallel “minibot” currency that neutralises the enforcement tools of the ECB.
His departure this week means that others will be left to grapple with Italy’s intractable stagnation. It is they who will have to push through €23bn (£21bn) of austerity cuts to comply with the EU’S stability pact and the fiscal compact, the paraphernalia of arcane budget rules concocted by lawyers and unworkable in a serious downturn. Mr Salvini’s hands will be clean. “It is a win-win situation for us,” said Claudio Borghi, the Lega’s economics chief.
The radical Five Star Movement has embraced its arch-enemy – the pro-eu, centrist Democrat Party (PD) – and formed an awkward coalition with no obvious mission other than holding power for its own sake.
The arrangement may not last a week. The Five Star’s techno-anarchist base are disgusted by what they deem political betrayal. Many may vote to reject the deal on their internal “Rousseau” website. This is a party that has long defined itself by revulsion for the PD party and the insider elitism it stands for. Yet its leaders are suddenly doing a backroom deal for reasons that look all too like patronage politics.
Italy’s president has opted for this odd coalition rather than accept a snap election that would double the Lega’s parliamentary seats and force him to accept Mr Salvini as premier – albeit at this point as a constrained premier without a super-majority. It is a gamble. Lorenzo Codogno, from LC Macro Advisors, says Five Star and the
PD will have to stick together through thick and thin for the next three years, and hope that the world will be a different place. “If the government collapses after six months it will be a tremendous gift to Salvini,” he said.
Bond markets love the new arrangement for now. Risk spreads on Italian 10-year bonds have dropped to a 15-month low of 171 basis points. Technocrats and the eternal mandarin class will be in full charge of the economy. The satisfaction in Europe’s high circles is palpable. Mr Salvini has been seen off.
The Lega leader has certainly suffered a big setback. He misjudged the landscape by precipitating the break-up of his party’s insurgent coalition with the Five Star. The public blames him for a needless summer crisis. Lega support has dropped from 39pc to 34pc.
But this snapshot of irritation tells us little. The Noto Sondaggi polling group said Mr Salvini may have lost some gloss but over the long run he will be more menacing in permanent campaign on the opposition benches.
The Lega leader calls the new government a pawn of “Merkel and Macron”. It is Mario Monti all over again, he says, evoking the technocrat regime imposed on Italy in the white heat of the EMU banking crisis in 2011. This time the pro-eu forces aim to ensure a compliant government in budget talks.
Italian GDP is still 5pc below its pre-lehman peak with insidious effects on debt dynamics. The economy has been bouncing along in recessionary conditions since early 2018. The debt ratio has crept up to 133pc and is on an unsustainable course for a country that cannot issue its own currency. Nobody knows when this might come to the boil. Right now markets are driving down yields everywhere to historic lows. Several European junk bonds are trading at negative yields. Italian state debt looks cheap by comparison. But this is a treacherous state of affairs.
The new Five Star-pd government may soon find itself having to manage the poisonous consequences of a world recession, one clearly signalled in inverted yield curves across the global bond universe. World trade is contracting at a pace of 1.4pc. Markets have latched on to talk of policy stimulus but the ECB is impotent.
‘The new government may find itself having to manage the poisonous consequences of a world recession’
Cutting rates further – beyond minus 0.4pc – hits the “reversal” threshold where it does more harm than good through multiple mechanisms: damage to banks; driving down inflation expectations and therefore raising real rates; and causing higher “precautionary savings”. All this is contractionary.
Nor is there meaningful fiscal stimulus on the way. Reform of the stability pact – the so-called “SGP 2.1” paper – is years from reality, assuming the northern bloc ever agrees to it. Daniel Hui, from JP Morgan, says fiscal expansion will not happen in Germany until there is a “deep recession”. It will not be pre-emptive. Donald Trump wants tax cuts but he is stymied by a Democratic Congress. “We think both German and US fiscal stimulus headlines are likely red herrings,” said Mr Hui.
Italy is cornered. A corpus of academic work blames the country’s malaise on sclerotic labour markets, broken courts and lack of supply-side reform across the board. This is all true. It is why productivity in the non-tradable sector has fallen a staggering 15pc (IMF data) since 1992.
Yet once a country gets into this predicament it takes drastic action to break free. My view is that Italy can escape the trap only through the electro-shock of a 30pc devaluation against the D-mark states, a 50pc debt haircut and fiscal expansion behind temporary capital controls – in other words, an Imf-style programme once it leaves the euro.
We are not there yet. The existing euro order in Italy is entrenched and will not give up without a fight. But as a matter of self-interest it surprises me that Italy’s “poteri forti” do not see the Machiavellian advantage of letting Mr Salvini win an election and take responsibility for the nasty 12 months that surely lie ahead, to soak his hands in blood so to speak.
Comparisons with Germany from 1930-1932 should be made with caution. The Lega is not ideologically fascist, and circumstances are different. But it should not be forgotten that the Nazi party was able to snatch the whole institutional system only after Germany’s political centre had immolated itself – by means of the Brüning deflation – on the pyre of the broken interwar Gold Standard.
The Italian and EU elites may regret allowing Matteo Salvini to sit out the coming slump with the irreproachable alibi of opposition.